Fed’s aggressive rate hikes raise likelihood of a recession

WASHINGTON

Federal Reserve Chair Jerome Powell has pledged to do whatever it takes to curb inflation, now raging at a four-decade high and defying the Fed’s efforts so far to tame it.

Increasingly, it seems, doing so might require the one painful thing the Fed has sought to avoid: A recession.

A worse-than-expected inflation report for May, consumer prices rocketed up 8.6 percent from a year earlier, the biggest jump since 1981, helped spur the Fed to raise its benchmark interest rate by three-quarters of point on June

Not since 1994 has the central bank raised its key rate by that much all at once. And until Friday’s nasty inflation report, traders and economists had expected a rate hike of just half a percentage point on June 15. What’s more, several more hikes are coming.

The “soft landing’’ the Fed has hoped to achieve, slowing inflation to its 2 percent goal without derailing the economy, is becoming both trickier and riskier than Powell had bargained for. Each rate hike means higher borrowing costs for consumers and businesses.

“There’s a path for us to get there,” Powell said on June 15, referring to a soft landing. “It’s not getting easier. It’s getting more challenging”.

It was always going to tough: The Fed hasn’t managed to engineer a soft landing since the mid-1990s. And Powell’s Fed, which was slow to recognize the depth of the inflation threat, is now having to play catch-up with an aggressive series of rate increases.

“They are telling you: “We will do whatever it takes to bring inflation to 2 percent,’ “ said Simona Mocuta, chief economist at State Street Global Advisors. “I hope the (inflation) data won’t require them to do whatever they’re willing to do. There will be a cost.’’

In Mocuta’s view, the risk of a recession is now probably 50-50.

“It’s not like there’s no way you can avoid it,” she said. “But it’s going to be hard to avoid it.”

The Fed itself acknowledges that higher rates will inflict some damage, though it doesn’t foresee a recession: On June 15 , the Fed predicted that the economy will grow about 1.7 percent this year, a sharp downgrade from the 2.8 percent growth it had forecast in March.

But speaking at a news conference Powell rejected any notion that the Fed must inevitably cause a recession as the price of taming inflation.

“We’re not trying to induce a recession,’’ he said. “Let’s be clear about that.”

Now, rising rates will squeeze the economy even harder. Buyers or homes and autos will absorb higher borrowing costs, and some will delay or scale back their purchases. Businesses will pay more to borrow, too.

And there’s another byproduct of Fed rate hikes: The dollar will likely rise as investors buy U.S. Treasurys to capitalize on higher yields. A rising dollar hurts U.S. companies and the economy by making American products costlier and harder to sell overseas. On the other hand, it makes imports cheaper in the United States, thereby helping ease some inflationary pressures.